Bank Recapitalization Monday

Those of you reading the news may be having trouble keeping all of this morning’s events straight. Here’s a quick summary:

The UK announced specific plans to recapitalize three of its largest banks – RBS, HBOC, and Lloyds TSB – with up to 37 billion pounds of government money. Separately, Barclays announced plans to raise money independent of the government. This seems to be the implementation of a plan that was announced last week.

Mitsubishi finally closed its deal to invest $9 billion in Morgan Stanley, gaining a 10% dividend on its shares (similar to Buffett’s investment in Goldman). This deal, which had been pending for weeks and some had given up for dead, will help boost confidence in Morgan Stanley. Note that unidentified sources have claimed that the US government promised to protect Mitsubishi’s investment; it’s not clear if that’s part of the final deal.

The Federal Reserve and several of its counterparts announced an expansion in the supply of credit to banks around the world in US dollars. The Fed said it will make available as many dollars as the other participating central banks need. They will then lend the money out to their banks against whatever collateral is appropriate under their rules. This is another move to increase liquidity in the financial system; however, for several weeks now it’s been apparent that liquidity alone is not enough to solve the problem.

Following yesterday’s agreement in principle, major Eurozone countries are announcing their rescue plans today, including both bank guarantees and recapitalization. Germany announced 400 billion euros to guarantee bank loans and 80 billion euros for recapitalization; France announced 320 billion for loan guarantees and 40 billion for recapitalization; Spain passed legislation providing 100 billion for loan guarantees and allowing the government to recapitalize banks by buying shares. I believe Italy is expected to make an announcement soon.

In summary, governments are taking the kind of steps that are necessary to halt the crisis. Loan guarantees and bank recapitalization are two of the steps we have been advocating. However, the jury is still out on whether they are coordinated and decisive enough. The much-followed TED spread (a measure of banks’ willingness to lend to each other) is only down by 7 basis points, although that may in part be due to the fact that the bond market is closed in the US today due to a holiday. All eyes are now on Washington, where a more definitive bank recapitalization plan is widely expected. Neel Kashkari, Paulson’s point man on the crisis, said today only that “We are designing a standardized program to purchase equity in a broad array of financial institutions.” (He said a lot of other things on a broad range of other topics.) Finally, this burst of support for wealthy countries’ banks could have unintended effects on emerging markets, as we discussed previously.

One response to “Bank Recapitalization Monday”

The largest banks in Europe and North America have been most affected during this crisis. I like to separate them according to the source of their woes. The large banks or building societies that had a relatively small international loan book but were very much involved in their domestic real estate finance markets e.g. WaMu, Wachovia, Bradford & Bingley, Northern Rock. The large banks that ended up with substantial tier-3 assets. And the large banks that were running substantial treasury gaps and had to face the interbank market drought.

All these three groups of banks have however been able to securitize their illiquid assets and offer them as collateral at their central banks’ regular re-financing operations.

Nothing has been said though about the other large banks that somehow managed to shift some of their tier-3 assets into their asset management outfits and placed them into some of their more aggressive mutual funds. As the possibility of massive withdrawals increases, I wonder how they will be able to raise the necessary funds to pay them back. As I see it, these bank recapitalization monies are not destined to finance mutual fund withdrawals.